How voluntary nonfinancial disclosure affects the cost of equity capital

Disclosure of nonfinancial information has become more prominent.†This article talks about the impact such disclosure may have on the cost of equity capital.

1. Voluntary disclosure of corporate social responsibility

Generally speaking, most financial statement disclosures tend to focus on financial data, such as operating income, taxes, and detailed information about assets. These disclosures are required under US GAAP because they enhance a userís understanding of the business and the data on the face of its financial statements. Other nonfinancial information is generally not required as long as omission of the information wouldnít be misleading. On the other hand, businesses are allowed to disclose anything they wish (again, as long as the disclosure isnít false or otherwise misleading).

In the last decade, a new nonfinancial disclosure trend has emerged: voluntary disclosure of corporate social responsibility. A corporate social responsibility disclosure informs financial statement users about corporate efforts in seven key areas:

  • Corporate governance (including transparency and accountability)
  • Diversity
  • Community (charitable giving and volunteerism)
  • Environment (green initiatives such as recycling and clean energy)
  • Employee relations (job safety, benefits, profit sharing)
  • Human rights
  • Product (innovation, whether the product benefits disadvantaged consumers)

This area of nonfinancial information disclosure and specifically disclosure of corporate social responsibility is of interest to accounting researchers.† For example, article ďVoluntary Nonfinancial Disclosure and the Cost of Equity Capital: The Initiation of Corporate Social Responsibility Reporting,Ē The Accounting Review 2011, covers this topic.† The article describes three statistical findings regarding corporate social responsibility disclosures:

1. A firm that initiates voluntary corporate social responsibility disclosure is more likely to realize a lower cost of equity capital.

2. A firm with a high cost of equity is more likely to disclose corporate social responsibility information in future reports than a firm with a low cost of equity capital.

3. Initiation of corporate social responsibility disclosure increases the likelihood of a future secondary stock sale.

Recall from our previous discussion about cost of capital that the cost of equity is a measure of the risk inherent in investing in a firmís stock. If the firmís stock is a high-risk investment, investors will demand a higher rate of return than a low-risk investment would offer. Based on the articleís findings, it seems that corporate social responsibility disclosures tend to reduce the perceived risk of investing in the firmís stock. Social responsibility can be tough to value, but there are definite intangible benefits to fostering a culture of satisfied employees, community involvement, and social accountability.

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